There is a famous saying which says ‘Do Not Fight the Fed.’
Many investors are taking that idea to heart, at least in one way….
Central bankers have been on a money printing spree. In Japan, they expanded monetary easing by ¥10 trillion. In the U.K., the Bank of England monetized another £50 billion of gilts. ECB President Mario Draghi promised “unlimited” bond buying, and the Swiss are committed to putting a floor under the Franc through unlimited purchases of Euros and other assets. David Einhorn of Greenlight Capital in his Q3 letter to investors.
If Chairman Bernanke is setting distant and hard-to-achieve benchmarks for when he would reverse course, it is possibly because he understands that it may never come to that. Sooner or later, we will enter another recession. It could come from normal cyclicality, or it could come from an exogenous shock. Either way, when it comes, it is very likely we will enter it prior to the Fed having ‘normalized’ monetary policy, and we’ll have a large fiscal deficit to boot. What tools will the Fed and the Congress have at that point? If the Fed is willing to deploy this new set of desperate measures in these frustrating, but non-desperate times, what will it do then? We don’t know, but a large allocation to gold still seems like a very good idea. Ibid.
While QEs 1 and 2 had no lasting impact, they did give a short-term boost to the stock market. But because that boost was ephemeral, it’s hard to comprehend why anyone would believe that QE3 will turn out better. QE3 is bold in its apparently unlimited determination, which may be intended to demonstrate the Fed’s determination rather than any actual conviction that it will work. Seth Klarman in his Q3 letter to investors.
The point of quantitative easing (QE) is to raise asset prices. This somewhat supports economic activity, but it does so inefficiently. Fed chairman Ben Bernanke evidently thinks that driving up the stock market will energize the entrepreneurial spirits of the 20% of the population who own 93% of all public equities, and this wealth affect will spur economic activity, eventually benefiting others. Paul Singer of Elliott Management.
The price of gold is near its all-time nominal high. We continue to believe strongly that it is undervalued and under-owned, and that it should have a place in most investment portfolios. Ibid.
Some investors, including David Einhorn, Paul Singer, Dan Loeb and Ray Dalio, have decided that purchasing gold is a great investment, as the Fed’s policies will increase the price of the precious metal. Seth Klarman does not own gold, but states in his shareholder letter that Baupost’s returns were in part driven by gold stocks. According to Baupost Group’s 13F, the value hedge fund bought 16 million shares of NovaGold Resources Inc., or, slightly over 2% of assets reported in the 13F. John Paulson has been a big gold bug, and is one of the biggest holders of the gold ETF (GLD).
Since the first round of quantitive easing was announced on November 25th, 2008, Gold has risen from approximately $800 an ounce to $1750 today, not a bad return.
However, many investors (including some of the famous ones mentioned) have in fact been fighting the Fed on another trade and losing money on that bet. The Federal Reserve can control (or some prefer manipulate) yields on Treasuries. Shorting treasuries has been a bad move, as has shorting Japanese Government bonds for the past twenty years. Some have made the comparison between Japan, the USA and Greece, due to high debt loads and money printing by the Central Banks of Japan and the US. These investors think that the USA and Japan will default just as Greece did.
The comparison of America and Japan to Greece is not a new phenomenon.
We will start off with Japan and Kyle Bass.
The argument is that Greece has a high debt load and was forced to default, therefore, Japan, which has the highest debt to GDP ratio in the world will also be forced to default. Kyle Bass, who made a lot of money off of sub-prime bets and his bet against Greek debt, has been shorting Japanese Government bonds, as he thinks that the market will start to focus on Japan. Kyle Bass reiterated his views at a recent investment conference. Just recently, Kyle Bass released a 30 page paper to defend his Japan thesis. Additionally, Kyle Bass owns a large stock of physical gold.
The reason why both Japan and the US are different than Greece is because both have a central bank which can purchase unlimited amounts of Government debt. Japan can never be at the will of bond vigilantes, because the country controls the rate it pays on its bonds. Many have termed the shorting of Japanese bonds, the Widow Maker trade, as so many investors have tried it over the past few decades, only to lose money.
Kyle Bass has lost a tremendous amount of money on this bet. According to a letter I obtained in May, Kyle Bass’ Japan Macro fund is down 60% since inception in July 2010. The macro fund is set to close three years after inception, which means Bass will likely lose money on this bet.
Besides investing in Apple Inc. (NASDAQ:AAPL), there is another popular trade for hedge fund managers. Many famous investors have also been shorting US debt since 2008, using the same reasoning as Kyle Bass uses with Japan. I have coined this the New Widow Maker Trade.
Baupost Group founder, Seth Klarman has been shorting US treasuries as well. Klarman compared treasuries to Greek debt in a recent shareholder letter. Seth Klarman is much smarter than I am, but he has been losing money on this bet, and I think he could fall prey to the massive fire-power of Ben Bernanke. Bernanke could make 10 year US treasuries yield 0.01% tomorrow if he wanted.
Paul Singer of Elliott Management, who has been in the headlines for his fight with the Government of Argentina, is also shorting US treasuries.
Seth Klarman and Paul Singer state that the reason they are short on US treasuries is because they found an incredibly cheap way of doing it. Additionally, this could be a hedge, since interest rates will rise eventually. However, US treasuries and Japanese Government bonds cannot be driven up by bond vigilantes since they have Central Banks, which is not the case for Greece.
While gold has been a winning bet, the other side of the trade, shorting treasuries, has been a big loser. 10 year treasuries yielded approximately 3.4% when the Fed announced the first round of QEI, today yields are closer to 1.6%, that is a big loss for fixed income especially.
One famous investor who has nailed both sides of the trade right is Jeff Gundlach of Doubleline. Gundlach has been buying gold on the dips, and has a large position in the precious metal in DoubeLine’s Multi-Asset Growth Fund. Gundlach has been extremely bullish on treasuries until recently.
To be clear, some investors, such as David Einhorn, have not shorted treasuries or JGBs.
However, the investors who are long gold and short treasuries, would do well to remember that when invoking the phrase not to fight the fed, they apply this logic across all asset classes. Otherwise, they fall at risk to The New Widow Maker trap.
Disclosure: No position in any securities mentioned.